Banks under pressure to increase small business lending

Banks could face possible tax sanctions if they fail to boost lending to smaller businesses.

The warning came from Business Secretary, Vince Cable, following the launch of the government's green paper on business finance.

Addressing the difficulties that many smaller firms claim they are facing in securing credit, Mr Cable said that the government could intervene to change the behaviour of the banks.

Mr Cable said: "The carrots include more guarantees and different kinds of guarantees. The sticks could include strengthening, widening the agreements we've already got."

One option would be for the Banking Commission to examine the advantages of breaking up banks to create more competition.

He added: "Or it could involve taxation of gross profits, something the Chancellor's already trailed, but if the banks insist on paying out large sums in dividends and bonuses rather than using that as a base of lending to good British companies, then that would be one of the potential sanctions open to us."

The Minister quoted figures from the Bank of England that suggested banks would have an additional £50 billion to lend if they capped bonuses at 2007 levels and dividends at 2009 levels.

While acknowledging that the banks are hampered in part by the need to hold more capital, Mr Cable nevertheless argued that there was a "very serious problem" with bank business lending and its effect on economic growth: "We can already see the evidence that finances are constrained and we don't want that to stop the recovery happening."

The green paper, entitled Financing a Private Sector Recovery, is designed to tackle the on-going problem of business credit.

The government said it recognised that access to finance is critical for businesses to survive and grow and that the current system is not adequately delivering finance to many small businesses.

The paper explores a series of finance options, including a greater use of equity and better incentives for venture capital and business angel investment in a wider range of enterprises, and a responsible return to securitisation.

It considers options for the finance industry, such as an insolvency moratorium on companies restructuring their debt, increasing transparency in bank loan applications and fostering competition between banks and finance institutions.

The paper reviews the success of existing government schemes, such as the Enterprise Finance Guarantee, and looks at whether they should be improved or extended.

It also outlines proposals for regional stock exchanges in cities such as Edinburgh and Nottingham.

Announcing the paper, Mr Cable said: "If we don't anticipate and tackle finance barriers now we could face a big problem in the future. Left unchallenged, a lack of accessible finance for businesses could prevent the recovery accelerating.

"I've heard the problems businesses are facing in getting bank loans up and down the country. They need innovative ways to access finance from other sources to grow our firms and economy. That's why this green paper is so important as we look to help viable firms get the money they need."

George Osborne, the Chancellor of the Exchequer, added: "As the economy recovers, it is crucial to ensure that the supply of finance supports rather than constrains demand and business confidence. If businesses are to play their part in promoting economic recovery it is important that they are able to access a diverse range of finance choices in a stable macroeconomic environment."

Reacting to the paper, David Frost, the director general of the British Chambers of Commerce, said that it was absolutely right to focus on the problems that many businesses are currently experiencing when it comes to securing funding.

Mr Frost continued: "Getting the existing concerns resolved as quickly as possible is essential if we are going to see a lasting private sector recovery.

"It is vital that the right approach is taken when dealing with the access to finance question. The situation is much more complex than simply forcing banks to lend when demand among businesses is anaemic. As the recovery gathers pace, we expect demand to rise along with some of the concerns businesses have articulated about bank lending.

"The banks must be as transparent as possible when decisions are made, and ensure that decision-making processes are not over centralised, tick box or removed from the front line."

Matthew Fell, the CBI's director for company affairs, welcomed the paper's recognition that the issue is a broader one than simply the unwillingness of the banks to lend and that the financial system needs to be assessed for its capacity to help finance economic recovery.

Mr Fell said: "It is right to acknowledge that, in order to lend, banks need certainty about future regulations, so that they can make decisions with confidence.

"We are also pleased that the paper is broad in scope, looking at a wide range of financing options from bank lending to equity finance."